Causes and effects of higher interest rates on student debt

Interest rate on student debt

Gerritsen explains that the interest rate on student debt rose because all interest rates recently rose. Specifically, when the European Central Bank raises interest rates, the Dutch government passes this on in their other loans. However, the interest rate on student debt is still considerably low.

Correcting inflation

A rise in interest rates often occurs when inflation is high, the Associate Professor notes. High inflation implies prices are rising, i.e., one can buy less with the same amount of money today relative to before. By raising the interest rates saving becomes more attractive whereas borrowing becomes less attractive. This diminishes the demand side of the economy, which should cool down the economy and thus the rate at which prices rise.

Winners and losers

A higher interest rate hurts people with debt. The higher inflation on the other hand, is good news for people with debt. Gerritsen explains that wages tend to grow proportionately with prices, due to which the relative size of debt decreases.

Repaying student debt

The Associate Professor remarks the institutional setting of the Dutch student loan system. After one is done with studying, he or she enters the so called ‘start-up-phase’ of five years in which the interest rate is fixed at the interest rate that applies when one enters this phase.

If the interest rate on student debt is low, it may be beneficial to allocate the borrowed money towards a savings account rather than repaying the borrowed money, the Associate Professor explains. This especially holds when the student debt interest rate is lower than, e.g., the mortgage rate.

Lower interest rates on student debt

When the interest rate on student debt decreases to zero percent, students will in a way be motivated to borrow as much as possible and consequently allocate the money towards a savings account, Gerritsen notes.  This benefits the student, but not the state treasury as money is never truly free. A zero percent interest rate on student debt is thereby funded by the Dutch taxpayers. In other words, a zero percent interest rate on student loans allows student to achieve returns, paid for by the Dutch taxpayer.